Economists expressed concern Thursday that prolonged escalation on the Northern border with Lebanon might pressure the government to increase the budget framework in 2007, though in the short-term a decrease of foreign direct investment and lack of tourism would only marginally weaken the economy.

IDF artillery fires shells at southern Lebanon on Wednesday.
Photo: AP

"The majority of the approved security budget cuts of half a billion shekels will most likely be cancelled considering the security escalations in the North," said Shlomo Maoz, chief economist at Excellence Nessuah. "The fighting in the north will require additional government expenditure of at least NIS 1 billion to be allotted to the IDF and for support of the local area in the North."

Maoz added that the question of the government now will be how to implement the additional funds needed without having to increase the budget for 2007. "I don't expect the economic growth rate to slow down this year, but the clashes in the North might slow down the economy by two percentage points in 2007."

It is difficult, Maoz noted, to use the economic impact of past periods of security escalations to measure the potential impact of the current situation since "it is the first time in many years that Israel has a strong and stable economy."

Prime Minister Ehud Olmert and Finance Minister Avraham Hirchson confirmed in a meeting on Thursday that the government had no intention of increasing the budget framework but instead would continue to work towards meeting the targets already set.

"Foreign investment is another major factor that may be influenced by the way the security crisis unfolds. Together with tourism, this factor is the most sensitive of all to volatility in the political and security situation," Maoz said.

Vered Dar, chief economist at Psagot Ofek said that while the financial markets would continue to face a period of uncertainty and the tourism sector was expected to be hit hard, economic growth might not necessarily be undermined.

"Economic implications of the unrest depend very much on the longevity and extent of the conflict," she said, but added that continued escalation as experienced during the second intifida with weekly suicide bombings would slow the country's economic growth rate of 5% to 2%.

"It's obviously too early to be sure where all of this is leading. But Israel's extreme reactions to both the Hamas kidnap of one Israeli soldier and Hizbollah's latest action do raise some thoughts. The most immediate of which is that having reacted in such an exaggerated manner, it may be quite difficult to find an easy way out of the current tension," HSBC said in in a research note. "There is a risk, therefore, that the violence could be prolonged."

If that's the case, "then we would be likely to see persistent downgrades to GDP and earnings numbers, which are likely to significantly weigh on banks' performance," HSBC added.

Meanwhile, Finance Minister Hirchson said the government would take all steps required to stay within its fiscal targets as fighting in Lebanon entered its second day and the Tel Aviv Stock Exchange continued to fall and the shekel weakened further.

"Despite the events of the last days, the fiscal policies the government has undertaken will be preserved," Hirchson said.

In the meeting with Olmert and Hirchson, the Governor of the Bank of Israel, Prof. Stanley Fischer, said the economy would remain stable and continue to grow, as long as the government maintained a responsible fiscal policy and implemented reforms.